2.5
Working Capital
Dr Salman Khan, Abu Dhabi Islamic Bank
Introduction
Capital investment is an obvious prerequisite for the establishment of new
businesses, firms and productive enterprises of all descriptions. However,
once they are in operation, businesses and firms also need to maintain access
to capital resources and liquidity on a regular basis in order to be able to
function smoothly and efficiently. This latter type of capital is defined as
working capital−“working” in the sense that it allows enterprises to carry
on working and functioning in accordance with their business objectives and
production goals. As a more formal definition, working capital is defined as
current assets of the business, less current liabilities, where the balance
provides the figure available to the business to develop, build, and expand
its operations further.
Working capital financing may be required for a number of purposes.
Among the most common of these are:
- raw material purchases;
- buying inventories;
- purchasing equipment/land/resources to expand productive capacity;
- advertising;
- paying staff salaries; and
- meeting other business-related costs (eg. utility bills, etc.).
Working capital loans
In conventional finance, the typical method of providing working capital
finance (WCF) is to advance a working capital loan to a business. The loan
may be of variable duration and value, depending on the requirements of
the enterprise. A conventional bank obtains its returnby charging interest
on the loan, which is usuallypaid back in instalments.
Often, but not always, such working capital loans may be taken for well-
defined needs of the firm that arise now and then, for instance to fund new
machinery. Alternatively, a finance facility or credit line may be made
available to a firm, such that over a specified period of time, the customer is
provided access to a certain amount of credit.
